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Notwithstanding ERISA’s fiduciary requirements, a significant portion of 401(k) plans establish investment menus with options that predictably lead to substantial underperformance of retirement portfolios. Utilizing data from more than 3,500 401(k) plans with more than $120 billion in assets, we provide evidence that fees and menu restrictions in an average plan lead to a loss equivalent to a reduction in expected returns of 78 basis points in excess of index funds. In 16% of analyzed plans, we find that, for a young worker, the impact of fees in excess of an index fund entirely consume the tax benefit of investing in a 401(k) plan. We also document a wide-array of “dominated” menu options, which we define as funds with fees significantly higher fees than comparable funds in the marketplace and no substantial contribution to menu diversity. We find that approximately 52% of plans offer at least one dominated fund. In the plans that offer dominated funds, dominated funds hold 11.5% of plan assets and these dominated investments tend to be substantially outperformed.

We argue that existing fiduciary duty law (aided by improved rule-making by the Department of Labor) can be used to challenge plans that imprudently expose investors to the risk of excess fees. In particular, we argue that (i) evidence of excessive fees can be powerful evidence of an imprudent fiduciary process, and (ii) fiduciaries act imprudently if they included dominated option in their menus, even if plan participants have other offerings with which to construct prudent retirement portfolios. But because heightened fiduciary duty reforms are unlikely by themselves to solve the problem of excess fees and dominated funds, we also propose three additional structural reforms: First, we recommend that the requirements for default fund allocations be enhanced to assure that the default investment is reasonably low cost. Second, we recommend that the Department of Labor (DOL) designate certain plans as “high cost” and mandate that participants in these plans be given the option to execute in-service rollovers to low-cost plans. Finally, we recommend that participants be required to demonstrate a minimum degree of sophistication by passing a DOL-approved test before being allowed to invest in any funds that would not satisfy the enhanced default requirement.